Welcome to the Risk of an Inflation Shock

Janet Yellen

The news is full of stories about deflation and negative interest rates, but take away the $80 a barrel decline in oil prices since March 2014, and the inflation trend appears to have popped up to more than 2 percent.

The decline in oil prices from March 2014 to March 2015 drove what economists call “headline inflation” for the Consumer Price Index For Urban Consumer (CPI) from +2.25 percent to -.25 percent.

But ever since then, the headline CPI has been creeping back up.

In January, headline inflation spiked up to 1.37 percent from 0.73 percent in December, despite the average cost of U.S. crude oil falling another 9 percent to $33.62 a barrel.

During the entire period of from March 2014 through November 2015, “Core CPI” (without food and energy) stayed relative stable at 1.7 percent. But core inflation in December broke out to 2.1 percent, and popped up to 2.2 percent in January.

Despite continuing reports of a deflationary economic collapse, as the U.S. price of oil plunged from about $110 per barrel two years ago to the current $31 a barrel price, U.S. wages have been accelerating since 2013 as labor markets continue to tighten.

Average U.S. compensation per hour rose just 1.1 percent from 2012 through 2013. But in both 2014 and 2015, average U.S. wages rose by about a 2.6 percent a year, a much faster rate than inflation.

Conservative economists, such as Marty Feldstein, who was President Reagan’s Chairman of the Council of Economic Advisers, blame the contraction of the U.S. labor particpation rate on the distortions from social programs, taxes, labor laws and regulations that have led many people not to want to work. That factor, they say is one of the reasons the U.S. has essentially run out of cheap labor–and hiring demand is now driving wages higher.

Breitbart News estimated in March 2015 that the economics of the U.S. oil boom meant that the U.S. fraking industry had about a $25 per barrel break-even price, due to the efficiency curve of shale production continuing to be more and more positive. That explains why U.S. production has not fallen. Any substantial uptick in the world price for oil will set off a huge surge in U.S. shale industry investment and production.

The Department of Labor reported 262,000 initial Jobless Claims on Feb. 18, bringing the four-week moving average down from 281,250 to 273,250. To put that in perspective, initial Jobless Claims in the U.S averaged 360,000 from 1967 through 2016, reaching an all time high of 695,000 in October of 1982 and a record low of 162,000 in November of 1968. The average for Jobless Clims has not been this low since 1973.

Investors are notorious for being wrong at just the right time about economic growth and interest rates. In October 2007, the Federal Reserve Bank of New York forecast that GDP growth for 2008 would be a positive +2.6 percent. But then the Financial Crisis hit, and 2008 GDP growth shocked Wall Street by tanking to negative 3.3 percent–a miss of about $860 billion in economic activity.

With the media and investors worried about deflation and negative interest rates, the five-year inflation expectation is only 1.46 percent, according to the rate of yield on U.S. Treasury Bonds. But if U.S. wages are breaking out to the upside, and oil has only limited downside, the U.S. may be at risk of an inflationary shock.


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